Heading Over the Fiscal Cliff

Nikola Altiparmakov, Member, Fiscal Council, is talking about the Fiscal Council perspective The Fiscal Council, warning that Serbia’s finances are on the verge of bankruptcy, predicts that Serbia’s galloping debt burden will worsen unless state spending is reduced, the private economy is encouraged and both public salaries and pensions gotten under control. Heading Over the Fiscal Cliff How dangerous is the current economic situation in Serbia? Like any household, a state cannot keep spending more than it earns or produces. Over the past 13 years of transition we have been spending more than we have produced. The public sector spends more; the private sector as much as it can afford. In the first years of transition we used to cover the deficit mostly with the proceeds from privatization. When those proceeds dried up, in 2007 and 2008 we started galloping into debt. Over the past five years we have doubled public debt from 30 per cent of GDP in 2008 to 62 per cent in 2013. Clearly, this trend is not sustainable. This has to change or a public debt crisis is unavoidable. In the past five years we have been able to get loans at seemingly good interest rates of 4.5 through 5 per cent. This was not a result of domestic efforts to achieve fiscal consolidation but of FED, ECB and even the Japanese Central Bank' printing money recklessly. They announced they would stop printing money in the next year and a half, and this immediately resulted in rising interest rates for all countries in the region. The interest rate for Euro bonds is now seven per cent, which is too high for Serbia. How are we to stop the galloping debt burden? The answer is simple. Expenditure must be aligned with revenue. As a society, we have been spending about ten per cent more than we have been producing for many years now. It would be ideal if our production went up by ten per cent and our standard of living stayed as it is, which, unfortunately, is not possible to do overnight. What signal are we sending to the market by not complying with the Fiscal Responsibility Act that envisaged a public debt of 45 per cent of GDP? Many European countries have been fiscally irresponsible over the past few years. A way of trying to turn the trend is emancipation and establishing institutions such as fiscal councils to raise citizens’ and politicians’ awareness. We are paying a high price for not complying with fiscal rules, but if we continue to behave like this, the price will be even higher. At some point investors will turn their backs on us completely and will not want to lend Serbia money. To prevent this from happening, we need to save money. Do you believe that the announced measures of saving will have effect? Will they be enough? The proposed set of reform measures and Budget revision should be observed independently. While the Budget revision is a short-term measure, the set of reform measures includes restructuring state-owned enterprises and amendments to the Labor Act and the Planning and Construction Act to facilitate the issue of building permits. The measures focus on cost-saving and stimulating economic growth. The proposed measures to stimulate economic growth are good and necessary; the cost-saving measures are a step in the right direction, but they are not enough. The Fiscal Council has welcomed the restructuring of companies that has been put off for years. State-owned enterprises undergoing restructuring eat up between 750 million and a billion euros a year either from the Budget or because they are not paying other public enterprises. Restructuring should be finished by mid-next year, and great progress has already been made. The good thing is that the Register of Public Service Employees is being compiled as we do not know who works in the public sector and what their qualifications are. We should not be surprised by the fact that we have a surplus of employees in public service since there is no way to control or rationalize employment in this sector. There is a surplus of employees in administration, a surplus of teachers primarily in elementary schools, and a surplus of non-medical staff in the health sector. There has been a substantial cut in the budget for capital investment. Is that a good move? Political economy shows that capital expenses are the first on the list when it comes to saving. They should be the last as they can stimulate the economic growth of the private sector and attract foreign investment. When 80 per cent of the Budget goes to salaries for the public sector, pensions and social expenses, and when a decision is made not to make radical changes there, then there is no room for reaction and capital expenses go bust. Will pay and pension freezes be necessary? Adopted indexation is very modest and very close to freezing, which is a good and responsible measure. On the other hand, budget deficit and public debt are so high that this is not enough. The fact that the public debt has doubled over the past five years means that interest costs have gone up from 200 million euros to about a billion euros, which is what they will be next year. Next year we will save one per cent of GDP on salaries and pensions but interest costs will increase by 0.4 per cent of GDP. The two extraordinary increases in pensions in 2008 of ten and eleven per cent, as a result of incorrect interpretation of interim legal provisions (i.e. 21 per cent) would shake the pension system in Germany, let alone in Serbia. Our estimate is that we will recover from the shock as late as 2016. The set of measures does not envisage pension reform. How will this affect public finances? The Fiscal Council has stressed that the pension reform is necessary. We have done the analyses and shared them with the Government. We have done a study of demographic projections for the next half-century. The results are not as optimistic as expected. It turns out that in 2050 Serbia’s population will be 5.2 million if the economic transition is successful and if we become an attractive country for immigration in the next 15 – 20 years. If this does not happen, Serbia’s population will be 4.5 million. The process of demographic aging is certain. Data show that in 1950 six per cent of our population was older than 65. This has now increased to 17 per cent and by the end of the decade it will be 21per cent t, with a tendency to reach 30 per cent by 2050. This requires not only pension reform but also other economic reforms. We proposed that the pension reform should include actuarial penalties as a mechanism for discouraging early retirement. At the moment, 70 per cent of men are retired before they turn 65, and 50 per cent of women retire before they turn 60. Actuarial penalties exist in all Western countries and in an increasing number of Eastern European countries. Croatia and Montenegro have introduced them, too. For each year of retirement before the retirement age the pension will be six per cent lower and for each year of retirement after the retirement age it will be seven per cent higher. The Government accepted this in its fiscal strategy, but the reform is absent from the latest measures. Whether it will be implemented and when remains to be seen. Will the budget revenue, which is very problematic this year, be sustainable without an additional increase in taxes? Strictly speaking, the reason for the Budget revision is the revenue, but the problem is really expenditure. Revenue has been lower this year because the plan was optimistic. There were some macroeconomic changes, too, such as slowing down inflation, which is good, but it affects revenue. The growing grey economy is also a reason for the revenue deficit. There is no more room for a further tax increase because the economy will not be able to hold up and it would be counterproductive. We have recommended a solidarity tax, which would apply only to the beneficiaries of Budget funds and it would not affect the economy. Will Serbia continue to need the IMF and why? The arrangement with the IMF is necessary because we need to regain the trust of the market. It is good that we have a short-term possibility to get a loan from the World Bank, but it cannot replace our arrangement with the IMF. Our reforms need the IMF’s stamp of approval because this is important for foreign investors. Foto: Ambro/ FreeDigitalPhotos.net Is it possible to make a preliminary assessment of the 2013 economic year? The growth of gross domestic product will be almost two per cent, which is good news, but we need to bear in mind that it dropped as much last year. The growth of GDP will depend on agricultural production and Fiat’s results. Apart from this, the rest of economy, such as small and medium enterprises, has not caught the same momentum and there will not be a tangible effect on the standard of living. The consolidated budget deficit will be about six per cent of GDP, not the predicted 5.2 per cent because revenue predictions were optimistic. Expenditure will be somewhat higher. Expenditure must be aligned with revenue. As a society, we have been spending about ten per cent more than we have been producing for many years now. AmCham Perspective Magazine

Heading Over the Fiscal Cliff

How dangerous is the current economic situation in Serbia?

Like any household, a state cannot keep spending more than it earns or produces. Over the past 13 years of transition we have been spending more than we have produced. The public sector spends more; the private sector as much as it can afford. In the first years of transition we used to cover the deficit mostly with the proceeds from privatization. When those proceeds dried up, in 2007 and 2008 we started galloping into debt. Over the past five years we have doubled public debt from 30 per cent of GDP in 2008 to 62 per cent in 2013. Clearly, this trend is not sustainable. This has to change or a public debt crisis is unavoidable. In the past five years we have been able to get loans at seemingly good interest rates of 4.5 through 5 per cent. This was not a result of domestic efforts to achieve fiscal consolidation but of FED, ECB and even the Japanese Central Bank' printing money recklessly. They announced they would stop printing money in the next year and a half, and this immediately resulted in rising interest rates for all countries in the region. The interest rate for Euro bonds is now seven per cent, which is too high for Serbia.

How are we to stop the galloping debt burden?

The answer is simple. Expenditure must be aligned with revenue. As a society, we have been spending about ten per cent more than we have been producing for many years now. It would be ideal if our production went up by ten per cent and our standard of living stayed as it is, which, unfortunately, is not possible to do overnight.

What signal are we sending to the market by not complying with the Fiscal Responsibility Act that envisaged a public debt of 45 per cent of GDP?

Many European countries have been fiscally irresponsible over the past few years. A way of trying to turn the trend is emancipation and establishing institutions such as fiscal councils to raise citizens’ and politicians’ awareness. We are paying a high price for not complying with fiscal rules, but if we continue to behave like this, the price will be even higher. At some point investors will turn their backs on us completely and will not want to lend Serbia money. To prevent this from happening, we need to save money.

Do you believe that the announced measures of saving will have effect? Will they be enough?

The proposed set of reform measures and Budget revision should be observed independently. While the Budget revision is a short-term measure, the set of reform measures includes restructuring state-owned enterprises and amendments to the Labor Act and the Planning and Construction Act to facilitate the issue of building permits. The measures focus on cost-saving and stimulating economic growth. The proposed measures to stimulate economic growth are good and necessary; the cost-saving measures are a step in the right direction, but they are not enough. The Fiscal Council has welcomed the restructuring of companies that has been put off for years. State-owned enterprises undergoing restructuring eat up between 750 million and a billion euros a year either from the Budget or because they are not paying other public enterprises. Restructuring should be finished by mid-next year, and great progress has already been made. The good thing is that the Register of Public Service Employees is being compiled as we do not know who works in the public sector and what their qualifications are. We should not be surprised by the fact that we have a surplus of employees in public service since there is no way to control or rationalize employment in this sector. There is a surplus of employees in administration, a surplus of teachers primarily in elementary schools, and a surplus of non-medical staff in the health sector.

There has been a substantial cut in the budget for capital investment. Is that a good move?

Political economy shows that capital expenses are the first on the list when it comes to saving. They should be the last as they can stimulate the economic growth of the private sector and attract foreign investment. When 80 per cent of the Budget goes to salaries for the public sector, pensions and social expenses, and when a decision is made not to make radical changes there, then there is no room for reaction and capital expenses go bust.

Will pay and pension freezes be necessary?

Adopted indexation is very modest and very close to freezing, which is a good and responsible measure. On the other hand, budget deficit and public debt are so high that this is not enough. The fact that the public debt has doubled over the past five years means that interest costs have gone up from 200 million euros to about a billion euros, which is what they will be next year. Next year we will save one per cent of GDP on salaries and pensions but interest costs will increase by 0.4 per cent of GDP. The two extraordinary increases in pensions in 2008 of ten and eleven per cent, as a result of incorrect interpretation of interim legal provisions (i.e. 21 per cent) would shake the pension system in Germany, let alone in Serbia. Our estimate is that we will recover from the shock as late as 2016.

The set of measures does not envisage pension reform. How will this affect public finances?

The Fiscal Council has stressed that the pension reform is necessary. We have done the analyses and shared them with the Government. We have done a study of demographic projections for the next half-century. The results are not as optimistic as expected. It turns out that in 2050 Serbia’s population will be 5.2 million if the economic transition is successful and if we become an attractive country for immigration in the next 15 – 20 years. If this does not happen, Serbia’s population will be 4.5 million. The process of demographic aging is certain. Data show that in 1950 six per cent of our population was older than 65. This has now increased to 17 per cent and by the end of the decade it will be 21per cent t, with a tendency to reach 30 per cent by 2050. This requires not only pension reform but also other economic reforms. We proposed that the pension reform should include actuarial penalties as a mechanism for discouraging early retirement. At the moment, 70 per cent of men are retired before they turn 65, and 50 per cent of women retire before they turn 60. Actuarial penalties exist in all Western countries and in an increasing number of Eastern European countries. Croatia and Montenegro have introduced them, too. For each year of retirement before the retirement age the pension will be six per cent lower and for each year of retirement after the retirement age it will be seven per cent higher. The Government accepted this in its fiscal strategy, but the reform is absent from the latest measures. Whether it will be implemented and when remains to be seen.

Will the budget revenue, which is very problematic this year, be sustainable without an additional increase in taxes?

Strictly speaking, the reason for the Budget revision is the revenue, but the problem is really expenditure. Revenue has been lower this year because the plan was optimistic. There were some macroeconomic changes, too, such as slowing down inflation, which is good, but it affects revenue. The growing grey economy is also a reason for the revenue deficit. There is no more room for a further tax increase because the economy will not be able to hold up and it would be counterproductive. We have recommended a solidarity tax, which would apply only to the beneficiaries of Budget funds and it would not affect the economy.

Will Serbia continue to need the IMF and why?

The arrangement with the IMF is necessary because we need to regain the trust of the market. It is good that we have a short-term possibility to get a loan from the World Bank, but it cannot replace our arrangement with the IMF. Our reforms need the IMF’s stamp of approval because this is important for foreign investors.